The Fed Blog

Tuesday, January 31, 2012

I’m not a big fan of leading economic indexes (LEIs). They can be quite misleading. They are constructed by well-intentioned economists with the intention of providing an early warning that a recession is coming in a few months or assurance that the economy is likely to expand in coming months. These man-made indexes combine a bunch of indicators that purportedly lead the business cycle. When they fail to do so, the men and women who made these indexes recall them, retool them, and send them back out for all of us to marvel at how well these new improved versions would have worked in the past. I can accurately predict that when they fail in the future, they will be recalled and redesigned yet again.

This just happened to the US LEI. The Conference Board has made the first major overhaul of the components of the LEI since it assumed responsibility of the index in 1996. It replaced real money supply with its proprietary leading credit index, and the ISM supplier delivery index with the new orders index. In place of the Thomson Reuters/University of Michigan consumer expectations measure, it will now use an equally weighted average of its own consumer expectations index and the current measure. Also, the nondefense capital goods gauge was tweaked to exclude commercial aircraft.

The impact of these changes has been shocking, and really questions the credibility of constructing LEIs. The old LEI rose to a new record high in November, exceeding the previous cyclical peak (where it hovered during 2006 and 2007) by 12.7%. The new LEI edged back up in December to its previous high for the year during July, but that’s 13.1% below the previous cyclical peak!

What about the ECRI Weekly LEI? It tended to track both the old and the new monthly LEIs prior to 2009. Since then, they’ve all diverged though the weekly index is now more in sync with the new one than the old one. Still, the weekly LEI has been very volatile and gave a misleading warning of a recession during both 2010 and 2011 (so far). (More for subscribers.)

Monday, January 30, 2012

The latest batch of US economic indicators was mixed last week. Thursday’s initial unemployment claims and durable goods orders data were upbeat, while Friday’s GDP report was lackluster. The best news wasn’t widely reported. I have started to monitor the Baker Hughes weekly and monthly census of the number of drilling rigs actively exploring for or developing oil or natural gas in the United States. Here are the latest developments:

(1) The weekly rig count rose to 2,008 during the week of January 27. The monthly rig count remained around 2,000 for the fourth month in a row during January. That matches the previous record high during September 2008, which was led by gas rigs. The rebound from 2009 has been led by oil rigs, which are up from a low of 187 during May 2009 to a high of 1,208 during January, the highest since 1987, when the oilfield services company separated oil and gas counts.

(2) The surge in oil rigs is starting to pay off in higher US production. Crude oil field production rose to 5.67mbd during the week of January 20, based on the 52-week moving average. That’s up from an August 25, 2006 low of 4.87mbd, and the most since May 28, 2004. (More for subscribers.)

Thursday, January 26, 2012

Most industry analysts who cover the S&P 500 companies are turning more upbeat about the outlook for revenues for this year and next year. However, the same cannot be said for their earnings forecasts. How can this divergence be explained? Obviously, they expect profit margins to narrow. The happy spin on this story is that analysts expect that their companies will be hiring more workers because their business has been so good that they must expand their payrolls. That will squeeze profit margins. But it will also boost sales. I don’t know if industry analysts are thinking this way, but it certainly explains the following facts on the ground:

(1) Revenues: After falling from a peak of $1,116 per share during the week of August 25, 2011 to $1,080 during the week of November 24, consensus expected S&P 500 revenues for 2012 flattened out around that level through the week of January 19. The 2013 consensus has been rising since late last year to a record high of $1,145.

(2) Earnings: Despite the stabilization in 2012 revenues expectations and their upturn for 2013, consensus expected earnings for the S&P 500 were at new lows for both years last week. This year’s estimate was down to $106.51, and next year’s was down to $118.96.

(3) Profit Margins: I use the consensus revenues and earnings data to calculate profit margins for the S&P 500 and its 10 sectors. These consensus expected margins have been falling for both years since last summer and are currently down to 9.7% for 2012 and 10.4% for 2013.

(4) Sectors: I also slice and dice the data for the 10 sectors of the S&P 500. Through the week of January 19, there remain upward trends in both 2012 and 2013 revenue estimates for the following: Consumer Discretionary (new highs), Consumer Staples (new highs), and Health Care (new highs). Flattening out recently are Energy, Industrials, Information Technology, and Utilities. Heading down are Financials and Materials. (More for subscribers.)

Wednesday, January 25, 2012

The regional business surveys conducted by the Federal Reserve Banks of New York, Richmond, and Philadelphia are available through January now. The overall indexes were upbeat, but they are seasonally adjusted. A few economists have recently argued that seasonal factors may be exaggerating the strength of the economy because they were distorted by the severity of the economic downturn in late 2008 and early 2009. The weather has also been unusually mild this winter. However, the details of the latest business surveys suggest that the fundamentals really are improving:

(1) New York Fed finds lots of strength in latest survey. The Empire State Manufacturing Survey indicates that manufacturing activity expanded in New York State in January. The general business conditions index climbed five points to 13.5, the best reading since April 2011, just before the soft patch. The new orders index rose eight points to 13.7, the highest since May 2011.

The six-month outlook continued to gain momentum in January. The future general business conditions index rose nine points to 54.9, its highest level since January 2011. This index has risen over 40 points since October.

On a series of supplementary survey questions, 51% of respondents indicated that they expect their workforces to increase over the next 6-12 months, while just 9% predicted declines in the total number of workers--results noticeably more positive than in the June 2011 survey. High expected sales growth was widely deemed to be the most important factor among those who planned to add workers.

(2) Richmond’s Fed survey was on the positive side. Manufacturing activity in the central Atlantic region advanced somewhat faster in January after firming in December. All broad indicators--shipments, new orders, and employment--landed in positive territory, with manufacturers noting their first increase in worker numbers since September. The manufacturing index rose to 12--up from 3 in December and 0 in November. Most other indicators were also positive, including capacity utilization.

Looking forward, assessments of business prospects for the next six months were more optimistic in January. The index of expected shipments increased nine points to 36, expected orders gained 11 points to finish at 32, and backlogs added eight points to 14.

(3) Philadelphia Fed survey also mostly upbeat. The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, edged up slightly from a revised reading of 6.8 in December to 7.3 in January. The new orders index remained positive for the fourth consecutive month but declined from a revised reading of 10.7 in December to 6.9 this month.

The future general activity index increased from a revised reading of 40 in December to 49 this month. The index has increased for five consecutive months and is now at its highest reading in 10 months. The current employment index has now been positive for five consecutive months, though it was virtually unchanged in January from last month’s reading. The percentage of firms reporting an increase in employment (21%) was higher than the percentage reporting a decline (10%). Among firms planning to increase employment over the next six to 12 months, the most frequently cited reason influencing this decision was the expectation of high sales growth.

So what worries me? I am concerned about the recent weakness in petroleum usage and electricity output in the US. The former fell during the week of January 13 to 18.98 million barrels a day (using the 52-week moving average to smooth out this volatile series). That’s down from a recent peak of 19.31mbd during the week of April 29, and the lowest usage since the week of July 11, 2010. Electricity output (also based on its 52-week average) was remarkably flat over the past year, but then dropped sharply during the first two weeks of this year. Maybe it’s just the weather.(More for subscribers.)

Tuesday, January 24, 2012

Despite Iran’s saber rattling, the price of oil hasn’t soared. The price of a barrel of Brent has been hovering around $110 since last summer. That’s even after President Barack Obama signed a bill imposing tougher sanctions on Iran at the end of last year. The price didn’t go up after the Iranians publicly threatened to close the Strait of Hormuz and warned Saudi Arabia not to fill any expected gap in oil demand when the world stops buying Iranian crude. According to a report in today’s Al Arabiya News, Iranian boats with men armed with machine guns on board were recently sent to the waters near the Saudi oil-production areas. Yet the price of oil hasn’t budged much from $110. Spain’s foreign minister said on Monday that Saudi Arabia has promised that it will make up for supplies of oil lost as a result of EU sanctions on Iran, and will do so at the same price.

If it weren’t for all the saber rattling, the price of oil would probably be falling. Oil Market Intelligence just released the latest data for global oil demand through December. It is weak. While the 12-month average rose to a record high of 89.3 million barrels per day (mbd) last year, the growth rate fell to 1.1% y/y. That’s down from a recent peak of 3.4% during January 2011, and the weakest since April 2010.

Demand is especially weak among the Old World countries of the US, Western Europe, and Japan--where crude oil usage has slipped back down in recent months to the 2009 recession low. On the other hand, demand in the New World rose to a record high of 51.5mbd last year, exceeding Old World demand by 36%. The growth rate of the former was 2.8% last year versus a decline of 1.2% for the latter.

The weakest oil demand, not surprisingly, is in Western Europe. It dropped to 14.3mbd, the lowest since the end of 1994. It had peaked at a record 15.7mbd during the fall of 2006. Crude oil usage also turned down in the US during the second half of last year. The 12-month average was down to 19.0mbd during December from last year’s peak of 19.3mbd during March. (More for subscribers.)

Sunday, January 22, 2012

The award for best-performing stock market last week goes to…Greece! That’s despite all the drama coming out of Athens. The Greek market rose 9.8% last week and is up 4.1% ytd. That’s after coming in dead last during 2011 with a loss of 51.9%. It’s been a come-from-behind year so far for lots of other losers of 2011. Most notably, China is up 6.8% ytd after falling 23.4% last year. Among the major MSCI indexes, Emerging Markets is up 6.0% after falling 16.6%. Europe is up 4.0% ytd following last year’s decline of 12.2%.

The World Stock Price Index (MSCI ACWI) is up 4.4% ytd after declining 7.6% last year. Last week, it rose back above its 200-day moving average. The US accounts for 45.7% of the index. Last year, the US was among the few safe havens for global stock market investors. So far this year it is a laggard behind many of 2011’s underperformers.

Still the S&P 500 is up 4.6% ytd. It’s actually on the verge of a bull market now that it is up 19.7% to 1315.38 from last year’s low of 1099.23 on October 3. Back then, it seemed to be on the verge of a bear market given that it had dropped 19.4% from last year’s peak of 1363.61 on April 29. It’snowonly 3.5% below that peak.

Now get this: The S&P 500 Industrials Composite rose to a new high last week for the bull market, which started in early March 2009. This index excludes the following three sectors: Financials, Transportation, and Utilities. The S&P 500 Transportation Index is only 3.8% below its record high hit on July 7, 2011. All 10 of the S&P 500 sectors rose above their 200-day moving averages last week. (More for subscribers.)

Thursday, January 19, 2012

It is my view that globalization is not the major cause of income inequality around the world. On the contrary, it is lifting standards of living almost everywhere. The emerging markets really started to emerge after the end of the Cold War. They benefitted from the integration of national economies through the proliferation of more trade. Most impressive is that while the value of the exports of the G7 industrial economies has increased 120% over the past 10 years, the value of exports of the rest of the world is up 275%. The share of G7 exports in total world trade is down from 50% during 1996 to 33% as of September 2011, while the share of the rest of the world has risen from 50% to 67% over this same period.

The main source of income inequality around the world is corruption. There are too many kleptocrats in too many countries who are gaming the system to swipe the gains from globalization. Many of the protestors around the world are specifically demonstrating against the corruption they see in their countries. If that leads to less corruption, that should mean that more people will continue to benefit from globalization and support it.(More for subscribers.)

Wednesday, January 18, 2012

The S&P 500 Transportation stock price index is only 5.6% below its record high of last July. The DJIA Transportation index is only 8.0% below its record high. That’s impressive given all the chatter last summer that the economy was growing at “stall speed” and could be heading into a recession.

I was in the “soft-patch” camp last spring. At the end of last summer, I was back in the “hard-patch” camp. It’s hard to worry that the economy is about to stall when the Transports are flying high. Nevertheless, we should stay close to the facts on the ground. Here are two relationships that we are monitoring closely:

(1) The S&P 500 Transportation index has been highly correlated with the CRB industrials spot price index. The former has been tracking the latter very closely since 2007. There has been a bit of divergence since early October of last year when the Transportation index rebounded sharply while the commodity index continued to fall. Commodity prices have firmed over the past few days on the perception that the Chinese authorities intend to stimulate their economy to keep it growing rapidly.

(2) The S&P 500 Transportation index also tends to track railcar loadings and truck tonnage. Although the Railroads industry accounts for 44% of the market capitalization of the S&P 500 Transportation index, the overall index isn’t as highly correlated with weekly railcar loadings or monthly truck tonnage as it is with the commodity index. Nevertheless, the underlying trends do coincide. Railcar loadings remained at a cyclical high during the first week of the new year at the highest pace since the end of 2008. The ATA Trucking Index (which measures tonnage) rose for the third straight month in November, matching its highest reading since January 2011 (which was the best since February). (More for subscribers.)

Tuesday, January 17, 2012

The US economy may be on the verge of a big comeback. It could experience an unusual second recovery over the next three years following the weak initial recovery of the past three years. In the past, recessions were followed by one broad-based recovery in economic activity. The Naysayers have been predicting a “double dip” recession for the US economy since it started to recover in 2009. I’m suggesting that a more likely scenario might be a double back-to-back recovery.

Our country lost lots of jobs during the recession. So far, the employment recovery has been anemic, with payrolls still 6.1 million below the record high set during January 2008. Instead of a normal V-shaped rebound, the housing industry has been in a depression, with the national single-family existing median home price down 28.9% since it peaked during July 2006 and foreclosures in the millions. The upturn in auto sales has been subpar. In addition, fiscal policy hasn’t been as stimulative as in past recoveries because there has been lots of fiscal drag from state and local governments.

Yet real GDP is up 5.5% from the recession trough during Q2-2009 through Q3-2011 to a record high of $13.3 trillion. That initial recovery was roughly half as strong as the average gain of 9.8% over the same period during the past seven recoveries. Since the official start of the latest recovery during July 2009, payroll employment is up only 1.1%, significantly lagging the average 5.1% gain of the previous seven recoveries over the same length of time--though it is on par with the last two “jobless” recoveries.

In the past, recessions were followed by one, not two recoveries. This time, key sectors of the economy haven’t participated in the initial economic rebound, but finally may be on the verge of doing so. The second recovery could take off as the pace of hiring quickens, housing activity finally picks up, auto sales head higher, and state and local governments stop retrenching. If so, then the US would finally enjoy the benefits of a broader-based recovery. (More for subscribers.)

Thursday, January 12, 2012

China’s CPI inflation rate edged down from 4.2% y/y in November to 4.1% in December. China’s PPI fell to 1.7% in December, the lowest since December 2009. That should set the stage for the People’s Bank of China (PBoC) to continue to lower bank reserve requirements, as it did on November 30 of last year (effective December 5). That was the first cut since December 2008. More cuts are likely to come as Chinese authorities scramble to offset weaker global economic activity with more domestic growth.(More for subscribers.)

Wednesday, January 11, 2012

I claim that initial unemployment claims may be the most important economic indicator for the stock market in 2012. It is one of the three components of our Fundamental Stock Market Indicator (FSMI), which is highly correlated with the S&P 500. It is a coincident indicator, which I use to confirm or question short-term movements and intermediate-term trends in the stock market. It worked very well in confirming last year’s range-bound market.

It is still range-bound, but has moved higher during seven of the past nine weeks and is approaching its February 2011 cyclical peak. The recent rebound is attributable to the sharp drop in initial unemployment claims late last year. Naysayers have been saying that this indicator’s seasonally factors can be faulty around yearends and may be exaggerating the improvement in the labor market.

They can point to the big jump in temporary hiring during Decembers by FedEx and UPS, companies whose business is boosted by increased holiday shipping. Those job gains were reversed last year during January, and that could happen again this year. Nevertheless, there are lots of other indicators confirming that the labor market is improving.

So if initial unemployment claims remain under 400,000 and possibly continue to head lower during January, that would support the strong stock market rally that has kicked off the New Year so far. Also supportive is the recent strength in the CRB raw industrials spot price index, which is another component of our FSMI. This commodity price index is also highly correlated with the S&P 500 Transportation index, which is only 5% below its record high of early last year. (More for subscribers.)

Monday, January 9, 2012

China’s stock market rallied yesterday on speculation that the government is taking steps to ease a credit crunch after the nation's new bank lending in December beat market estimates. The benchmark Shanghai Composite Index gained 2.9%, or 62.39 points, to close at 2,225.89 points, which marked its biggest advance in almost three months. Investors also seemed to take comfort from a statement posted over the weekend by Premier Wen Jiabao, who said that a difficult global environment made addressing problems in China’s own financial system more urgent. Wen suggested stock market investors' rights should be better protected.

On Sunday, the PBoC reported that the country's banks lent 640.5 billion yuan in new yuan-denominated loans in December, a sharp rise from 562.2 billion yuan in November. M2 was up 13.6% y/y at the end of December, higher than the 12.7% rise at the end of November.

The Chinese stock index is highly correlated with the CRB raw industrials spot price index. The former dropped 23.4% last year, while the latter fell 11.5%. The stock index was 16.4% below its 200-dma at yesterday’s close. I expect that the Chinese stock market will rebound this year as the PBoC lowers bank reserve requirements to ease credit conditions in order to stimulate economic growth. That should boost commodity prices.

Japan’s Nikkei is also highly correlated with the Chinese stock market. That’s not surprising given that China is Japan’s largest trading partner. In 2002, China beat the US to become the largest source of imports to Japan. In 2009, China displaced the US as the largest export market for Japan.(More for subscribers.)

The US labor market is improving, but not as rapidly as suggested by some of the numbers released last week. The ADP survey of private payrolls showed a gain of 325,000 during December, while the official BLS survey found a gain of 200,000 during the month, with private payrolls up 212,000 and government employment down 12,000. While these numbers are seasonally adjusted, they might have been boosted by some seasonal distortions:

(1) The ADP data for the month of December are notoriously volatile. Unlike in the official BLS employment report, employees of ADP's clients typically remain on payroll records until December whether still employed or not, with those no longer employed subsequently removed from the records at the end of the year. Difficulties adjusting for this sizeable seasonal movement have the potential to distort the December ADP employment numbers.

(2) Transportation and warehouse payrolls are also volatile now at year ends.They jumped 50,200 during December, accounting for 24% of the increase in private payrolls. Last year, they jumped during December by 50,100, but then dropped 47,200 during January.(More for subscribers.)

Thursday, January 5, 2012

Yesterday, I noted that industry analysts have been lowering their earnings estimates for Q4-2011 since last summer. I attributed their downbeat reassessments to mounting concerns that Europe is falling into a recession. They must believe that it won’t be a long-lasting depression because they are already raising their 2013 estimates for revenues. They started doing so late during 2011 and ended the year with an estimate of $1,143 per share for S&P 500 revenues, up 5.2% from their 2012 estimate, which also edged up at the end of last year after dropping during the summer. This year’s revenues are expected to be up 3.6% over last year’s sales.

Offsetting analysts’ concerns about weaker growth overseas, particularly in Europe, is better than expected growth in the US in recent months. They must expect it to continue. That’s evident in the revenues data that I monitor every week for the 10 sectors of the S&P 500. What I see is solid upward trends in 2012 revenue estimates for Consumer Discretionary, Consumer Staples, Health Care, Information Technology, and Telecom Services. Flattening or declining 2012 revenues expectations are visible among the following more globally exposed sectors: Energy, Financials, Industrials, and Materials. Looking out to 2013, the only one of the 10 sectors that’s been showing falling revenues estimates in recent weeks is Materials.

While the analysts’ outlook for revenues is looking up, they have been consistently reducing their consensus expectations for the profit margins of the overall S&P 500 as well as most of its sectors for both 2012 and 2013. I calculate these margins from the data compiled by Thomson Reuters on consensus forward earnings and forward revenues. So the 2012 estimate for the S&P 500 fell to 9.7% at the end of last year, the lowest since I started to track the data in September 2010. The 2013 estimate fell to 10.5% at the end of last year, the lowest for this series, which I’ve been monitoring since September of 2011. (More for subscribers.)

Wednesday, January 4, 2012

January’s earnings season is about to start. Industry analysts have been curbing their enthusiasm for Q4-2011 since last summer, when their consensus expected earnings estimate for the S&P 500 peaked at $26.73 a share during the week of June 3. By the final week of 2011, it was down 8.8% to $24.39. That would put Q4 earnings up only 8.2% y/y, the first single-digit comparison following eight consecutive quarters of double- and triple-digit increases.

Interestingly, the current estimate for last year’s Q4 is the same as the estimate for Q3 at the start of that earnings season. The actual result reported during October beat expectations by more than a buck, yet analysts continued to trim their Q4 expectations. Obviously, they were unsettled by mounting prospects of a financial meltdown and a recession in Europe.(More for subcribers.)

There was a proliferation of negative Net Earnings Revisions among the 10 S&P 500 sectors during December. They were all negative for the second month in a row. Some have been negative for the past three or four months. The overall NERI for the S&P 500 turned negative during September (-0.2), and remained that way in October (-6.0), November (-10.5), and December (-8.9). The good news is that the overall index is highly correlated with the purchasing managers’ index for manufacturing, which rebounded nicely in December. The bad news is that the proliferation of downward revisions may have more to do with weakness in overseas business for the S&P 500 companies, particularly in Europe, where PMIs remained weak during December. (More for subcribers.)

Monday, January 2, 2012

The ECB joined the QE Club of Central Banks. It did so indirectly when 523 European banks borrowed €489 billion through the ECB’s Long Term Repo Operation (LTRO) on December 20. That liquidity facility will be available to the banks again on February 28.

In addition, the ECB is likely to lower its official rate from 1.00% to 0.75% on January 12. The rate of growth in the euro zone’s M3, which the ECB uses as a gauge of future inflation, fell to 2.0% in November from 2.6% in October. Growth in loans to households and companies also slowed, while inflation in Germany, the region’s largest economy, decelerated in December.

The ECB’s assets shot up by €239.4 billion to a record €2.7 trillion during the week of December 23, led by a €214 billion jump in lending to euro zone credit institutions in euros. The Fed’s central bank liquidity swap facility rose $45.5 billion over the last two weeks of December. Those funds were mostly borrowed by the ECB and re-lent to European banks needing dollars. This showed up as a €25.3 billion increase in the “claims on euro area residents in foreign currency” on the ECB’s balance sheet over the two weeks through December 23.

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ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.

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